Hard Learned Lessons; You Can Do Everything Right and Still Get Screwed

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This is the industry. Snowboarding. Some are in it to make a buck, some because they love the sport and just want to make a living doing what they love. Occasionally, the two collide and the golden rule prevails; the one with the gold makes the rules. When there’s a business lesson to be learned that might help some others, I get involved. My name’s Harbaugh. I carry a pen (well, actually a key board).

 I was working the day watch out of the precinct office when the phone rang. The boss’ name is Stouffer. My partner is O’Brien.
 
The story you are about to hear is true. The names, places and other details have been changed to protect the innocent.
 
Dum, Da Dum Dum……..Dum!
 
“The fact is I thought I had everything covered. I thought I was on the money with that letter of credit. I thought there was no way I’d get screwed with that letter of credit.”
 
Ralph thought he finally had it made. All he really loved to do was build stuff and when he learned to love to snowboard and found that he could make money building boards, it seemed like it was all coming together.
 
Not that it was easy. There were the usual startup/entrepreneur/cash flow challenges. It was 1994 when he took a salary for the first time; $25,000. The company did 4,000 boards that year with fifteen employees, one press and a simple production line. They produced for half a year. 1,500 were their own brand (let’s call the brand and the company “Burp”), and the remainder for other brands.
 
A 1995 order for $1.3 million and 8,000 OEM boards convinced him he was over the hump.
 
“I was completely ready for it. I had the process down and I knew where I wanted to go. All I needed was the volume to get up so I had enough machines. So I had a constant flow through the shop and I figured hey, get it to that point, get it running smoothly and then I can concentrate on Burp.”
 
The first 5,000 of the 8,000 board order were manufactured, shipped and paid for. The buyer called back with a problem with the inserts, which was fixed at Burp’s expense. Before making the rest of the boards, they created four samples with the insert problem corrected and sent them to the buyer for approval. They were approved, in writing, and Burp geared up to produce the boards to that newly agreed upon standard.
 
That’s when the buyer tried to cancel the remainder of the contract. But with the materials bought, that wasn’t really an option for Burp. It took the buyer around a month, until October, to determine that the boards would be produced under another label, and the order was upped to 4,000 from 3,000. A shipping schedule was agreed to and Burp began to produce.
 
The first 400 boards are shipped and paid for with no problem. The second 500 are ready to ship on time and on schedule and the buyer says “Hold it, we don’t have an address for you to ship them to.” A week later, Burp finally gets permission to ship them; to the buyer’s warehouse.
 
Ralph is starting to get nervous. He’s been shipping these boards, and getting paid, under a letter of credit. The buyer’s delays have meant that there are only fifteen or so days to ship the remainder of the product and present the documents before the letter of credit expires. It could only be extended with the cooperation of the buyer, and Ralph isn’t feeling too confident that they will be willing to do that.
 
Another thousand boards go out the door and at this point, the nameless buyer owes Burp $350,000. Another week goes by and another 500 boards are ready to go. His bank tells him he hasn’t been paid for an earlier shipment, and the buyer’s bank pleasantly informs him that their are discrepancies in the letter of credit.
 
A letter of credit is an agreement whereby a bank agrees to pay the beneficiary (in this case, Burp) a certain amount of money based on the presentation of very specifically prepared documents usually indicating the shipment by the specified means of certain goods. If any detail is incorrect, the account party (the entity that had the bank issue the letter of credit; in this case the buyer) can refuse to honor the letter of credit. Incorrect details are called discrepancies.
 
I can’t recall ever seeing a letter of credit without a discrepancy. Ralph was new to the letter of credit game and didn’t know about discrepancies.
 
“I called them (the buyer) up and asked what’s up. They drug it out for three or four days. I stopped manufacturing at this point because I didn’t have any money to pay my guys for two weeks and this is like three weeks before Christmas. Bad scene. ******* is the heroin user capital of the world. I’ve got some burley ass dudes working for me, 38 of them. And when you come to them and tell them they can’t get their pay check…..three days before Christmas, your talking about some pretty pissed off guys.”
 
The buyer claimed there were only two and a half instead of the industry standard three turns on the inserts. Ralph didn’t know what the hell the industry standard was, but he knew he was producing the boards to the standards they had all agreed to in writing. He put the extra half turn on the boards in the warehouse at Burp’s expense.
 
For the next few weeks, Ralph is the beneficiary of an education that’s not in the curriculum at any business schools. For reasons Ralph has a hard time figuring out, the CEO of the buyer gets involved. He pressures Ralph to ship the remainder of the product, but won’t pay what is already owed. He tells Ralph he’s going to take his house through some mysterious legal mechanism that was never made clear. Endless conversations, attempted negotiations, and confrontations go nowhere. People show up from the buyer with a truck on three separate occasions to pick up the product, but they have no authority to pay for it.
 
When December 31 comes around, the CEO suddenly disappears from the picture. There’s no resolution, and no decision maker for Ralph to talk to. He’s $550,000 in the whole, his business is on the verge of collapsing, and he’s got nowhere to go.
 
“These guys lied to me, straight up lied to me. This guy told me that a company check could not be revoked, a wire transfer could not be revoked, every time he’s telling me this I’d call my bank and say, listen, if a wire transfer comes from *************** how long does it take? They said it takes about four days. Okay, can it be revoked? Sure.”
 
Having run out of options, and with his company and personal assets on the line, Ralph filed a lawsuit against the buyer for $4.8 million. His attorney told him he’d win, but it would take something like three and a half years. Both he and his company would be in bankruptcy almost immediately.
 
His attorney went back to the buyer and made a deal. The buyer got the product, Ralph got some money, they signed mutual releases and walked away from each other. But the money wasn’t enough to cover all the debt.
 
Ralph’s only solution was to sell the company. There was plenty of interest, but when the smoke has cleared, there was only one buyer for the company remaining. Let’s call it the ABC company. ABC was willing to buy the assets and pay the creditors $0.45 for each dollar they were owed over three years. Ralph’s job was to convince them to take that. Overall, the deal was worth something like $400,000.
 
Ralph spent six months trying to bring the only three creditors who didn’t quickly agree to the deal into line. He couldn’t do it. Ultimately, it got too late in the year to make the season and ABC pulled out. At this point the major secured creditor, the bank, finally said they’d do it, but it was too late.
 
Ralph went back to ABC. The bank foreclosed on the assets, and ABC bought the assets, including the Burp name, from the bank for $85,000. The unsecured creditors got nothing and the bank got less than it could have gotten had it agreed to ABC’s original deal earlier.
 
Ralph works for ABC now. He’s running their factory, doing what he likes to do, and the business is well capitalized.
 
“At the end of the day, if everything had worked out, and I had made the product and shipped it and they (the buyer) accepted it, I would have been in the plus; not substantially, not like I thought I would be, but I would be in the plus. I would have paid back all my trade debt no problem and I would have been half way strong going into next year. Instead I was sitting there with $350,000 worth of debt.”
 
SIDEBAR:
 
Hard Lessons Worth Remembering:
 
1)    Letters of credit are gnarly documents
2)    Agreements are only as reliable as the people you make them with.
3)    Nothing ever works out quite the way you expect it.
4)    There isn’t always time to learn; know what you don’t know.
5)    A bank’s decision making process can be hard to figure out.
6)    When all is said and done, all you’ve got is your integrity, your ethics, and the relationships you build with people.

 

 

US Market Conditions and the Globalization of Snowboarding

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Last year when somebody said to me “Write about US market conditions” it was easy. You could think of the US, Japan and Europe as distinct markets and approach the trends in each accordingly. But overcapacity and the slowing of growth have made that harder, and the interdependence of the three markets has become much more obvious.

Let’s at least start in the US at the Transworld industry conference in Vail. We’ll see that the issues on everybody’s mind reflected what’s happening in the US market, but that those conditions are at least partly the result of developments in the rest of the world.          
 
The 7th Annual Transworld Snowboarding Industry Conference in Vail, Colorado December 11th to 14th reflected US industry and market conditions perfectly. The familiar companies were all represented. But the number of total participants dropped to around 500 from closer to 600 last year with some smaller companies apparently not surviving. The new CEO’s of Morrow, Ride and Sims (David Calapp, Bob Hall, and Jim Weber) attended their first industry conference, highlighting a trend towards increasing professionalization of management.
 
There were attendees from a handful of record companies, some ski resorts and a couple of winter sports trade associations. They were all there to learn about snowboarding and, hopefully to help snowboarding with its inevitable move into the mainstream.
 
Presentations and seminars were better attended and the attitude was more businesslike than last year. I’m sure this had something to do with the fact that Transworld decided this year not to have open bars in the back of the rooms where the presentations were taking place. But it also reflected an emerging realization that industry over supply and some slowing of growth were making this a tougher market for everybody and creating survival issues for some.
 
Europe was represented by Harry Gunz from Rad Air and Charly Messmer from Generics and Blax. Salomon Snowboards had five representatives in addition to a contingent of four from Bonfire. Charly got some publicity for Generics and Blax the hard way, by hitting a rock in deep powder on day three. His board stopped, but he didn’t and the result was one broken ankle and one chipped one. No, of course you weren’t out of bounds Charly.
 
When last seen he was lying in bed smiling and seemingly unconcerned about the whole thing. I don’t think the pain medication had worn off. Anyway, it’s the time of year when he should be working, not riding.
 
The conditions in Japan were lurking in the back of everybody’s mind. Oversupply there (an estimated 300 to 350 thousand boards) has made it impossible to look at the three major geographical markets independently of each other. Many US companies had relied on cash deposit from Japan and/or site letters of credit to fund their production. It was clear those days are over for most companies. US retailer orders have to be expected to decline to the extent they represented gray market product shipped to Japan. Airwalk, Sims and probably others I don’t know about have seen some of their product show up in the retail warehouse giant Price/Costco and are moving aggressively to plug the leaks that allowed it to get there in the first place.
 
Good early season snow conditions in most of the US and mid November opening dates at many resorts are no doubt benefiting sales. My perception is that Burton and Mervyn Manufacturing (Gnu/Lib Tech) are overall the best positioned brands. Morrow, Ride and Sims are all dealing with the results of oversupply to the Japanese market and with management and organizational changes.
 
David Calapp joined Morrow as Chief Executive Officer only in August of this year and Dennis Shelton resigned shortly thereafter. David is experienced in sporting goods, but not in snowboarding. The brand is strong in the US but faces challenges in Europe and Japan. The recent announcement (during the Vail conference) that the company would not achieve its earnings projections for the year caused the stock to fall 27% in one day. Morrow’s response was to announce a buyback of 5% of its stock on the open market. 
 
Jim Weber, at Sims, has been in his new position almost a year. Like Calapp, he came to the job with sporting goods, but not snowboarding experience. His first major challenge was to prepare Sims to delivery a quality product on time. He believes the company is prepared to accomplish that. The second was to gain control of the brand. The lawsuit against DNR is being settled in Sims’ favor, with the company now controlling its distribution worldwide.
 
Bob Hall joined Ride as Chief Executive in August, 1996 with a strong background in winter sports including skiing and consumer goods. His immediate challenges were to rebuild the management team and restructure a company that suffered from very rapid growth and losses of key management people in many areas. The restructuring he accomplished quickly. Rebuilding of the management team is an ongoing process.
 
The major asset of most companies in the snowboarding business is their brand name. Many people, including myself, are of the opinion that a correct business strategy in the current environment is to protect that brand name through better control of distribution even though some sales volume will be sacrificed. Hopefully, the company will be compensated by higher gross margins on a product that is harder to find. As public companies, Ride and Morrow will have a harder time than other companies pursuing this strategy with shareholders looking for growth.
 
But don’t despair if you are a shareholder. The issue of which companies will be among the leading brands in the US is largely decided. They may fight for position against each other, but they will be here. It’s the smaller companies who have been dependent on Japan, who’s product lines are incomplete, and that are under financed that may have survival issues to deal with.
 
Ski Industry America’s retail audit numbers for the period from August through October 1996 seem to confirm these conclusions. They report that specialty store snowboard sales were up only 12% during the period by volume. In dollars, the increase was only 1%, indicating that average retail price of a board is continuing to drop. That average price was $294.00 during this period. 
 
What we see in these statistics seems to be confirmed by my discussions with retailers. Boards are harder and harder to sell at full margin. There is too much supply out there, and a more knowledgeable consumer has figured out that there isn’t that much difference among the major brands. I’ve heard of brands selling boards in quantity to close them out at $85 a board or even a little less. The result is that price has become a key factor in selling boards in the US.
 
As I’ve indicated, it’s become increasingly difficult to separate conditions in one market from those in another. That’s made very clear by an excellent report prepared by Robert C. Marvin and C. Heath Glennon of The Seidler Companies in Los Angeles. It’s called The Snowboard Industry 1996/97. You can call for your own copy at (213)-624-4232. Since I couldn’t say it any better than they do, let me quote them at some length.
 
“We estimate that the number of snowboards shipped (excluding OEM boards) to retailers by the five major manufacturers will increase about 26% from 1995/96 to 1996/97 and that the top five will account for about 45% of total boards shipped worldwide as compared to 35% in 1995/96. This should mean trouble for many of the other 200+ snowboard companies.”
 
“Unfortunately, it does not appear that the excess inventory problem will end with the 1996/97 season. We believe snowboard production for the 1996/97 season will again approach 1.9 million units. Add the 425,000 units of 1995/96 inventory that are still around and there will be about 2.3 million snowboards available for sale in 1996/97. Even if demand grows 25% to 1.5 million units, there will be 800,000 units left over in March of 1997.”
 
The report goes on to produce a similar analysis of boots and bindings, and concludes that there are excess inventory problems in both these categories and that “…snowboard boot inventories at retail were an even bigger problem than board and binding inventories.”
 
My own analysis suggests that board production this year probably exceeded 1.9 million and that production capacity may be close to 3.0 million boards.
 
This article started in Vail, Colorado but ends with a focus on snowboarding as a maturing, global business.  The markets can’t be viewed in isolation of each other any more. They never could, I suppose, but the illusion that they were separate was fostered, to some extent, by a demand that exceeded supply. Obviously, that period is over. Welcome to the world snowboard market. 

 

 

Minding Your Own Business; How’s Your Shop Doing?

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Last month in this space I suggested a simple system for tracking your financial results with the goals of having better control and being able to react to surprises. If you use it for, say, six months, you are going to have some good information that will have helped you manage your shop. The next step, which this article addresses, is to use the information collected over a period of time to help you answer the fundamental question “How am I doing and what can I do better?”

The National Ski and Snowboard Retailers Association (NSSRA) can help you answer that question with their biannual cost of doing business financial survey. 64 shops responded to the survey for the 1995-96 season. NSSRA segmented the shops according to their revenues levels and calculated key performance measures so that shops can compare their performance to the others producing similar revenue.
 
 Some of the gross data was presented in last month’s Transworld Snowboarding Business. Below, selected information from the survey is presented in a different format and how you can interpret it discussed.   The table below highlights some data across the complete revenue range that I think is particularly interesting. It’s instructive to look at how you’re doing compared to shops your size, but it can be equally interesting to see how things may change (or not change) with revenue growth.
 
 
 
 
 
 
Total Company Revenue:
 
 
 
 
 
 
Under
$500,000 to
$1 to $2
Over
 
 
 
 
 
$500,000
$1 Million
Million
$2 Million
Income Statement (%of Total Revenues)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Sales of Merchandise
 
 
92.9%
94.5%
92.6%
95.4%
Operating Margin
 
 
 
46.9%
41.0%
43.7%
40.0%
Total Payroll (including tax & benefits)
 
22.0%
18.0%
19.2%
18.7%
Occupancy Expenses
 
 
7.4%
5.8%
5.8%
7.8%
Other Operating Expenses
 
 
14.4%
11.3%
12.4%
12.0%
Net Income Before Tax
 
 
3.2%
5.7%
6.4%
1.1%
 
 
 
 
 
 
 
 
 
Key Performance Measures
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner’s Compensation & Profits to Revenue
 
12.6%
10.3%
9.9%
5.4%
Total Square Feet Per Store
 
 
3,300
4,800
5,700
5,571
Selling Square Feet Per Store
 
 
1,800
3,200
3,500
4,333
Total Revenue Per Selling Square Foot
 
$243
$258
$368
$230
Total Revenues Per Total Equivalent Employee
$95,219
$80,297
$123,811
$115,900
 
 
 
 
 
 
 
 
 
Median Revenue Per Company
 
 
$460,816
$650,000
$1,400,000
$4,500,000
 
Before you start interpreting this data and applying it to your situation, remember that every statistical analysis has flaws. Unless you understand how it was collected, and compiled, you can reach bad conclusions using it.
  
Tom Doyle, President of NSSRA, reminded me that it tends to be the more sophisticated and better organized shops that return the survey, so the results may not be representative of “typical” shops. The survey also includes balance sheet data, but I’ve purposely excluded it from this discussion. In seasonal industries, a good company can have a strong balance sheet in January and a lousy one in July. Unless all the balance sheets are as of the same date, the survey results can be meaningless. Since we don’t know what those dates are, I’d take the balance sheet data with a grain of salt if you get the survey for your shop.
 
Don’t get too focused on comparing percentages. The absolute numbers do matter. An 85% gross margin won’t save the day if your total sales are $75,000.
 
According to Tom, the sample size is large enough to be statistically valid even when the responding shops are divided among the four revenue categories. But if you were to select different revenue ranges, you might see dramatically different results. I also get nervous about the sample size when, for example, they divide the respondents in one revenue category into the lower 25%, the middle 50% and the upper 25%. At that point, each of those segments may have so few data points that one unusual value dramatically changes the result. About all that can be done to remedy this problem is to get more of you to participate in the survey. 
 
Even though the word snowboard has been added to the association’s name, only about six percent of revenue of the responding companies is from snowboarding. Don’t stop reading. As far as I know, we don’t have any better information to work with, and if half the revenue were from snowboarding, I don’t think the calculations would turn out to be much different. 
 
So now, keeping these possible shortcomings in mind, you can go into this analysis with your eyes open. First, look at what happens to the various indicators as revenue grows. As median revenue grows from $460,816 to $650,00 (41%), owner’s compensation and profits (OCP) grow only from $58,063 to $66,950 (15.3%). From a strict financial point of view, the additional effort and risk may not be worth the additional income to the owner. But going one growth step further, median revenue growth from $650,000 to $1,400,000 (115%) yields a comparable increase in OCP of 107% to $138,600.
 
 
If we take the last step up, sales increase by 221%, but OCP is up only 75%. This isn’t surprising. You can see that most of the expense reductions take place between $500,000 and $2,000,000 in revenue. Payroll, occupancy and other operating expenses each drops a couple of points.   Operating margins are lowest for the companies over $2 million in sales.
 
A strict financial analysis then, suggests that an appropriate revenue goal for a shop is somewhere between $1 and $2 million, because that’s where you seem to get the most operating efficiencies and to maximize your pretax income as a percent of revenue. Too small an operation has to spend too high a percentage of its revenues on fixed costs. Too large and your profitability drop because you do not hold your margins and your revenue per selling square foot declines. Larger companies typically are less riskier than smaller ones and can attract capital with less trouble and at a lower cost. Perhaps a lower return on incremental sales is justified by reduced risk to the owner/investor.
 
If one use of this data is to plan your financial future, another is to manage your present business. Tom Doyle relayed a couple of instances in which his members used it to save some money.
 
In one case, a shop used it to negotiate a better deal on its lease. They showed the survey data to the landlord and successfully argued that they couldn’t afford to pay a higher percent of revenue for rent than their competitors. In another case, an owner noted that his insurance expense appeared very high as a percentage of his revenue. A few phone calls confirmed that there were better deals available.
 
Recognize that just because your shop is above or below a particular indicator doesn’t means that you have a problem or are doing exceptionally well. Evaluation of financial indicators is a dynamic process; each indicators affects others. Your goal is to understand why the variance exists and either be comfortable with it or make some changes.
 
Get a copy of this study from NSSRA. Check out the methodology so you understand what they are doing. On a piece of paper, write down as few or as many of the statistics for shops your size as you want. In the next column, calculate the numbers for your shop. In the next column record the positive or negative variance.
 
Where the absolute numbers or the percentage variance is very small (less than 5% either way?), ignore it. Where the variance is significant, write down what you think is the explanation in the next column. Note both positive and negative variances. Spending too little on something can be as bad as spending too much.
 
Where you don’t have an explanation, take the time to find one. The survey indicates that the cost of insurance for a company doing between $500,000 and $1,000,000 is 1.2% of revenue. It also says the middle range (the 25% on each side of the median) is from 0.4% to 1.7%. So maybe if your percentage is 3.2 you want to call your agent and cancel the rider that covers you against the invasion of the body snatchers. On the other hand, maybe you’re strategically situated on the hills outside of Sarajevo, and no matter what the percentage is, you think a little more business interruption insurance might be just the ticket.
 
This isn’t about comparing percentages. The term “insurance” covers a lot of things (never buy it when you’re playing blackjack) and just because your expense as a percent of revenues is different from what some study finds doesn’t mean you should change. Maintaining a higher gross margin, for example, may require that you spend more on advertising.
 
This survey is a screening mechanism that can highlight, without much effort, areas where improvement in your shop’s financial performance might be possible. It doesn’t provide black and white answers, but can be a valuable guide. Use it as a tool to help you think about your business, but temper any conclusions you reach using it with knowledge of your special circumstances.

 

 

Selling Your Business How to Get Ready and What to Expect

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At some point, every business owner considers selling their company. Most that don’t go out of business are sold at some time in their history. But between considering it and selling are a host of issues, surprises, conundrums, and general confusions for the business owner who has never been through the process before. I have spoken with or heard of sellers who are minimizing the chances of making a good deal by

·         Requiring that the buyer make an offer before seeing the seller’s financial statements
·         Stating prices that are so unrealistic as to make any further discussion futile
·         Hoping to close a sale without using appropriate professional advisors.
 
If you’re going to sell your business, let’s make sure you do it right and for the right reasons. You can maximize your chances of success, and minimize wasted time, by focusing on what I call the five “Gets.” Get real, get a goal, get ready, get agreement, get help. 
 
Get Real
 
It’s as predictable as the sun coming up in the morning. The owner believes in his business. He believes in it so much that his perception of what it is worth to a buyer is, in my experience, almost always out of line. 
A sophisticated buyer won’t ignore your projections, but he will discount them very heavily. He will recognize the growth potential of your business, but balance that with a realistic assessment of the competition. He will want to know very specifically why you have been or will be successful. He will base his offer to you on the potential return he objectively thinks he can earn compared with other investment opportunities he has. In determining his maximum purchase price, he will value your business in ways that are standard for valuing companies in this or similar industries.
 
He will recognize that your growth depends on increasing working capital investment in the business and that he, not you, is the one who is going to have to take that risk. He will admit that there are some synergies in combining the two companies, but will believe (probably correctly) that his organization will be more responsible for achieving them than yours. Accordingly, he will be reluctant to pay you for them. He will understand that the business is dependent on you and perhaps a few key managers, and will be concerned with your motivation once the deal is closed. So if you expect to receive the value you perceive in your business you should expect to do it in an earn out.
 
He will look closely at your historical financial statements. They will frequently be the single most important (though not the only) factor in determining the price he is willing to offer and no amount of explaining, rationalizing, projecting or shucking and jiving will change that.
 
So, to begin, make a realistic estimate of the value of your company. There are many ways to value a company. None of them give a right or wrong answer. But when you are done, and you may need help to do it, you will have a reasonable range of value for your company. You may also want to value it under different scenarios. For example, your company may be worth more as part of a larger organization because your sales will no longer have to support, on a stand alone basis, all the overhead expense you currently have.   Value it, in other words, as the potential buyer would to get insight into his thought process.
 
This knowledge is a powerful negotiating tool. Make sure you have it.
 
Get A Goal
 
What do you want to accomplish by selling (besides get money)? What do you want to sell; assets or equity? How do you want to get paid? Will you take stock? Cash at closing only? Is an earn out acceptable? What will be your role be in the business after the deal closes? For how long? How hard do you want to work following the sale? What is the minimum price you will accept? 
 
There is no way to know if an offer is a good one or a bad one unless you know what you are trying to accomplish by selling the business. You always want the other side to put the first offer on the table, but you never want them to be able to control the negotiating process because you haven’t thought long and hard about what a good offer looks like. You can be successful in your negotiations if you know specifically what you want to accomplish and why.
 
The converse is that you must also know when to walk away. If you are desperate for a deal, you’ll get a bad one.
 
Get Ready
 
From the time the first contact with a serious purchaser begin, it you can generally expect it to take six months or longer to close a deal. But preparations may begin literally years earlier, when the owner concludes, based on the kind of valuation and goal setting described above, that her best long term strategy is a sale of the business.
 
Try and increase awareness of your company among potential buyers. You can do this, for example, by being active in the appropriate professional associations. Get articles about your company published in trade journals. You may be better positioned to negotiate if the buyer comes to you. 
 
Have systems that prepare consistent, accurate financial statements and information that can be easily verified or audited. It’s a critical element in determining a purchase price and an important indication that you are a competent business person the buyer can rely on to operate the acquired business.
 
Clean up your balance sheet. Get rid of old inventory and write off uncollectable receivables. It’s never a good idea to fool yourself about the value of assets, and you won’t fool a potential buyer. But by not making these adjustments you may find your own competence and credibility questioned during the acquisition process. “What other surprises are hidden here?” wonders the potential buyer.
 
Have a current business plan that validates your strategy. Make sure the warehouse is brightly lit and painted. If there’s any tax issues, litigation or disputes with employees out there, settle them.
You can’t put your best foot forward if it’s stuck in the mud.
 
Get Agreement
 
This may seem a little obvious, but it’s a good idea if all the shareholders agree with the decision to sell the business and have a common understanding of what constitutes an acceptable deal before the negotiations begin. Legally, it’s possible to sell a business with the approval of less than 100% of the ownership. But in a private company, with only a few shareholders, it can be difficult. A buyer may be concerned about litigation by a minority shareholder. If a dissenting shareholder is expected to continue to work for the acquired company, an uncomfortable operating situation can result.
 
While you can’t please all of the people all of the time, it’s usually a good idea to try and get acceptance (enthusiasm would be nice) from other key stakeholders. These may include customers, suppliers and key employees. At the very least, make sure they have good information about what is going on as negotiations reach their final stages.   They will all be asking “How is this going to affect my relationship with this company?” and you need to have an honest and accurate answer.
 
Get Help
 
Sale of a company demands an accelerating time commitment from the owner. My experience is that as the deal gains momentum, you can either manage your business or work on the deal. There’s often not enough hours in the day to do both well.
 
Let’s look at a typical scenario. You’re selling the business you built. It’s your baby. You’re proud of it, and are far from objective. To make it more interesting, you’re entering into a process with which you have little or no experience. And this deal is potentially the most important and lucrative transaction you have ever entered into.
 
Let’s say that on the other side of the table is the representative of a larger company. He’s been through this before and knows what to expect. At the end of the day, whether or not there’s a deal, he gets paid the same and goes on to work on the next deal. He’s completely dispassionate and may not have any stake in the outcome.
 
Somewhere in the course of the negotiations he looks at you and says, “I assume you’re willing to warrant that there are no outstanding disputes with any federal, state or local tax authorities except as disclosed in appendix A of the agreement?”
 
Now, a good response, assuming it’s true, is something like “I’m willing to warrant it to the best of my knowledge,” but if you’ve never done this before, you might not know that. Happily, you’ve got an attorney sitting by your side to handle those kind of issues.
 
But if he’s the attorney who drafted your will, helps you collect from delinquent creditors, or kept you out of jail after the IRS audit, he may be waiting for you to speak up. Your attorney must be experienced in representing sellers of business.
 
The same is true of the other professionals who may work with you; your financial advisor, tax accountant, business valuation advisor and possibly others. Get help. Do it right. You may only get one chance.

 

 

SIA 1996; It’s Just Business

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Business. It was all business.

 
Well, maybe not quite all. The ladies and gentlemen at Mervin Manufacturing were dressed in all white outfits (they claimed not to be angels) and Mike Olsen was shooting money out of a cannon at irregular intervals.   But the snowboard side of this year’s SIA show in Las Vegas showed that the industry is maturing. There were the usual crowds and noise and excitement. But there was also, especially among the larger companies coming to dominate the industry, a more subdued sense of purpose and focus.
 
They weren’t there to have fun; they were in Vegas to do business. 
 
You felt it as soon as you saw the booths. Many were the size of my house, except my house doesn’t have a second story . Now I know why Morrow did a public offering. To pay for their booth.
 
Larger, sleeker, cleaner, sophisticated, with more controlled access and private rooms for meetings and order writing. Less beer being consumed during show hours. No companies thrown out for use of controlled substances. To put it succinctly, snowboard industry leaders had booths that looked, well, like ski company booths; except they were busy.
 
This was the year where it seemed that the ten or so companies that control 70 plus percent of the US snowboard business heaved a collective sigh of relief. They knew snowboarding was here to stay. They knew they were going to have a prominent part in it. They realized that the small, undercapitalized companies not being run like businesses would disappear or, at worst, be like fleas on a dog; occasional and momentary distractions.
 
Their focus was on taking market share before the competitive situation solidified and establishing their positions against the other large players.
 
Their tools were complete product lines, payment terms, discounts, pricing, reliable delivery and customer service coupled with marketing and promotional programs only they could afford. Retailers, nervous after late deliveries, poor and/or late snow in much of the US, and left over inventory didn’t have to have their arms twisted-much. Their interests, and those of the Burton/Sims/Ride/Morrow/Mervin snowboard juggernaut generally coincided.
 
Now under these circumstances, you might expect that the size of the show would have stabilized or (be still my heart) even declined a little. Nope. Booths spilled out into the lobby and took over the meeting rooms on the second floor. I don’t know how much of the growth was the result of companies taking more square meters, but I’d estimate there were a couple of dozen new snowboard companies. Or at least people with boards in booths hoping to become companies. The directory lists about 300 snowboard brands in total.
 
My conversations with them tended to be the same as with other new companies last year. They had limited capital and product lines, no competitive strategy, and couldn’t explain how they were going to differentiate themselves. If I hear “We’re closer to the market than our competition” one more time, I’ll shoot myself (I shouldn’t say that. I’ll be dead at the next trade show.). I didn’t have the perception that these companies were writing any significant orders, though of course you can’t expect anybody at the show to say “We’re doomed” when you ask them how it’s going.
 
There didn’t seem to be much change in board design or construction. What I did notice was the size of the line of some of the players. Between the Ride, Mercury, Liquid and 5150 brands, Ride, if I counted right, had 84 boards. Let’s see a sales rep put all those in his van. Graphics were simpler and colors varied but muted. Yellow seemed popular. As companies go mainstream, the goal of graphics seems to be not offending anybody.
 
Traditional bindings offered incremental improvements. The hot product had to be the step in bindings. In addition to K2’s Clicker, Switch and Device, Wave Rave, Blax and Marker/DNR had models to sell. Burton didn’t have one, but was taking orders anyway. That’s market power.
 
Over 300 companies were listed in the show directory as offering snowboarding apparel. The statistics I’ve seen indicate that Burton and Columbia by themselves account for 50 percent of sales in the US, making it pretty clear that many of these companies have their work cut out for them if they are going to succeed.
 
One thing I didn’t see at the show was the usual number of representatives from Japanese companies frantically looking for new snowboard product lines. This seems consistent with current conventional wisdom about oversupply and general competitive conditions in Japan. As discussed below, it has critical implications for the viability of a large number of US snowboard hard and soft good companies.
 
Essentially, what happened was that companies were pushed down the feeding chain. Larger companies tried to require bigger commitments from retailers, pushing out second tier brands. These brands sold to stores they had not previously done business with to try and maintain their volume. The smaller companies were pushed out of these stores, sometimes leaving them with no place to go.   
 
What was seen at the show has been confirmed in the six weeks or so since it ended. I’ve had calls from perhaps half a dozen smaller apparel companies who did not write the anticipated orders at the shows, and who’s Japanese orders have been significantly reduced or are not yet received. At least one larger apparel company has picked up an additional distributor in Japan because of the reduction in orders from its existing distributor. Where orders have been placed, there’s increasing reluctance to provide the historically favorable financing terms of 50% down and 50% sight letter of credit.
 
In the US hard goods reps for other than the major companies are having a hard time getting orders, and personal relationships appear to be the key factor in determining their success. 
 
Retailers are cautious in their ordering. Often they are already committed to the major suppliers. In addition, some have more stock than anticipated left from last year.
 
A new factor seems to be retailers perception of product availability. Historically, companies produced only what they could sell in the preseason, and retailers were confronted with an inability to get reorders. Late season availability was not a problem last year. Late deliveries and poor snow conditions in much of the country meant retailers were getting called by snowboard companies with product to sell at attractive prices. Combined with the increased availability of quality domestic manufacturing, retailers seem comfortable in holding back some of their open to buy for later in the year.
 
An industry consolidation does not start with a bang at a particular moment in time. However, the SIA show this year made is absolutely clear that the long awaited consolidation isn’t just starting. It’s in full swing.

 

 

Hard Choice Time; Strategies for Success in the Snowboard Industry

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It all kind of came together for me at the industry conference at Banff, though I couldn’t say if it was on the lift, in the spa or at the bar. Probably at the bar. The time is over when a small or medium sized independent player in this industry can just focus on getting from one year to the next. If all you think about are tactics and operations, chances are that one year soon, you won’t make it even as the industry as a whole continues to prosper.

 Your choices are pretty clear cut. There are four. They are discussed below. The goal of this article is to motivate you to dispassionately evaluate your business and the market, and then actively pursue one of the four. To do that, we’ll consider the impact of some recent industry transactions and identify the problems that most smaller companies say they have in common.   To begin, we’ll get past some of the hype and excitement of snowboarding and look at it as another industry starting to enter its maturing phase.
 
In 1980, a Harvard professor named Mike Porter wrote a book called Competitive Strategy. The whole volume is worth your consideration, but Chapter 11, “The Transition to Industry Maturity” is especially relevant at this time in the industry’s evolution. I think we can safely assume that Dr. Porter was not a snowboard pioneer, but his discussion of what happens in a consolidating industry (any consolidating industry) will look ominously familiar to anybody who thinks about what snowboarding is going through.
 
Step One in our analysis, then, is to agree that as much as we may love it, and as exciting as it may be, the evolution of this industry won’t ultimately be different from that of any other industry. At this point in time, the only difference I perceive is that it is happening faster than it does in most industries. I believe that’s because there are really no significant barriers to entry, but the fact that you have to commit to the next season before the last one ends makes it hard to get out.
 
No entrepreneur succeeds without an almost heroic belief in themselves and their business; if they didn’t have it, they would never take the risk.   It can be difficult to have an objective perspective on industry trends and the potential of their company. The euphoria engendered by rapid growth, the hype of any fashion related business, and the fact that companies try to make themselves look bigger than they really are (except Burton and Gnu/Libtech, who seem to want to look smaller) can make it tough to be dispassionate.
 
Get dispassionate. Talk to business people outside of snowboarding. Set some measurable goals. Figure out what success means (hopefully more than bare survival). Formally decide if the risks are worth the potential returns, financial and other.
 
Step Two is to look at some recent industry transactions to figure out why, in general terms, they happened and what their impact on the industry may be.
 
Let’s see, Morrow went public, Salomon bought Bonfire, Ride bought Thermal, Hooger is buying American Snowboard Manufacturing, Madison Sport bought Purged/Mantle and Variflex bought Plunkett Snowboards, Inc. What’s going on?
 
Companies are building their balance sheets, vertically integrating their businesses, associating themselves with stronger partners, developing year round cash flow, and generally positioning themselves to survive and compete with lower margins on higher volume. 
 
Are we shocked by all this activity? No, because under Step One we agreed that the same trends that occur in any other maturing industry will also occur in snowboarding.
 
Let’s look specifically at the Variflex deal. Variflex produces protective equipment and in-line skates that it sells directly to large retailers.  In May 1995, it acquired Plunkett Snowboards, Inc. to produce its Static brand of snowboards. Variflex’s goal at the time was to produce a board that retailed in the $300 price range but was comparable in features and quality to the most expensive brands.
 
Because Variflex sells directly to retailers, from a financial perspective this goal won’t be difficult to achieve. Based on my discussions with a number of board manufacturers, I’d estimate that the cost to produce a high quality board in volume is probably under $90.00. Let’s say it is $100 and the board is sold to a retailer for $140 to give Variflex a 40 percent margin over cost. The retailer wants to make their traditional 40 margin too, so the consumer pays $233.
 
Hey, what happened to the $300 retail price? Remember this is a bit of a moving target, and K2 already has the Dart out for a suggested retail of $270. K2 and Variflex are both selling direct, as is Elan with the Nale brand. Eliminating the profit for that extra middleman frees up a lot of margin.
 
Happily, there’s more than financial calculations at work here. Even in skiing, brand names and marketing keep retail prices higher than they need to be from a financial perspective. Nobody is going to scurry to give up margin before they have to. But I do see the day where a high quality wood core board will retail not too far north of $200. With boots and bindings, there appears to be more of an opportunity to keep margins up through technological innovation, assuming you can afford the cost of developing those innovations. 
 
Step Three is to identify problems most companies have in common. One’s obviously price pressure. It’s more or less important depending on your market segment and size, but it exists for everybody.
 
A second is inability to differentiate a brand. Most smaller companies are unable to spend enough to make an impression in the market. Even when they do spend it, it gets lost among the hundred of brands trying to do the same things, driving operating margins down even further.
 
A third issue is the working capital requirements of a highly seasonal, fast growing business. Success probably requires you grow at least as fast as the market. Seasonality, and the increasing tendency of retail accounts to require longer terms, means you have to tie more and more capital up in the business for longer and longer periods. Many company’s’ track records and profit potential don’t justify either a loan from a bank or an investment. Lacking a rich uncle or a trust fund, it’s going to be tough to come up with the money. 
 
Fourth is dependence on the Japanese market. A few months ago, several sources estimated that there would be 800,00 boards brought into Japan this year. Interestingly, I’ve also heard 400,000 and 1.2 million. Maybe 800,000 is a reasonable number.
 
I don’t know what reality is in the Japanese market. But I am certain that the days of 50 percent cash deposits and 50 percent site letters of credit are going to vanish. Companies creating brands that are sold only in the that market should not expect those brands to survive. How will they replace that cash flow?
 
In summary, then, margins are declining while required marketing costs increase. The financing
necessary to grow quickly enough so that volume offsets reduced margins is, at best, difficult to find. Cash constraints will be accentuated by changes in the Japanese market.
 
Step Four is to look at possible strategies given the conditions and market evolution described above. There are four of them.
 
The first is to find enough capital to reach a volume world wide, as a manufacturer or a wholesaler, that makes you a “player.” That is, that puts you in a position to compete at least partly on price and to be profitable under the circumstances described above. As a stand alone snowboard industry company, if you aren’t close to being there now, you probably won’t be able to get there. The reason is that you won’t be able to show the return on investment required to attract the funding.
 
The second, in theory, is to find a market niche where you can differentiate yourself so that brand loyalty offsets sensitivity to price and, to some extent, insulates you from the emerging competitive conditions. I say “in theory” because the only company I believe has really accomplished that is Mervin Manufacturing, and they’ve done it by having a consistent focus over a period of years. Nitro, with what I’ll call their high tech, retro-ski approach to advertising this year, may be trying to establish a niche for themselves and I think they’ve got a good chance to do it. Not a jumping rider in sight on some of their ads. For a long time, they tried to disguise the fact that they were a European owned company. Now it looks like they are using that “liability” as a strength.
 
AK Bommer Boards in Valdez, Alaska is another good example of a niche strategy. They make individual custom snowboards. “Big Boards for Burly Riders with Big Feet” it says on the business card. As a guy with a size 13 attached to my leg, I called for information. Probably won’t ever be a big company, but at $500 a board, their margins should be okay and their break-even point low.
 
They have the additional advantage of knowing exactly who their market is; “Big Boards for Burly Riders with Big Feet.” Think of the power of that phrase. With those eight words they know exactly who their competitors and customers are and what their position in the market is. Consider the efficiencies it gives them if only because they don’t waste advertising and promotion dollars.          
 
The problem is that there are too many companies and not enough niches, and no niche completely insulates you from price pressure. Sales dollars required to break even are rising, and I expect they will continue to do so.
 
The third strategy is to become a product line of a larger company with year round cash flow. You share overhead, facilities, possibly distribution channels and reduce your break-even point. Year around cash flow eliminates or at least reduces the annual crisis of working capital common to one season businesses.
 
A corollary to this strategy is to find someone better capitalized than you are to distribute your brand. You continue to control product development, and maybe advertising and promotion, and earn a royalty on sales. It’s probably a lower return strategy, but it’s lower risk as well.
 
The fourth strategy, which is inevitably the least popular, is to pack up and go home. If you go through the kind of analysis suggested above and can’t find a way to implement one of the three strategies I’ve identified, maybe the chances of success don’t justify the risk and effort anymore.
 
There’s actually one more strategy, if you want to call it that. It’s what I characterize as the “more of the same” approach. This will prove to be the most popular approach and some companies taking it will succeed. A lot won’t. There’s not much to this; just keep doing whatever you’ve been doing before and hope it works. Every company has a strategy- even if it’s a bad one and they didn’t actively chose it.
 
I know how hard it is to find time to deal concretely and dispassionately with issues of strategy when you’re trying to run a company. But the surest path to failure is to be caught in between strategies, unable to compete on price and not having established a defensible market niche. If you are caught there you aren’t going to enjoy it, and you aren’t going to survive.
 
SIDEBAR:
 
Trends In Any Maturing Industry
Shamelessly plagiarized in a good cause from Competitive Strategy by Michael E. Porter
·         Firms sell to experienced, repeat buyers who shift their focus from the decision to buy to choosing among brands.
·         Industry profits fall. Smaller firms are most affected. Cash flow declines when it is most needed, and capital becomes increasingly difficult to raise.
·         Danger of over capacity accentuates the tendency towards price competition.
·         Company attitudes must be disassociated from the euphoria of the past.
·         New products and applications become harder to develop.
·         Dealer margins fall, but their power increases as more brands compete for shelf space.
·         Slowing growth means more competition for market share. Frequently that competition can border on irrational.

Competition may emphasize cost and service

 

Big Air; Initial Public Offerings in the US

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Open on the table next to me I have the preliminary and actual prospectus for, respectively, Morrow and Ride Snowboards initial public offerings. As of December 13th, 1995, my broker assures me, Morrow is not public yet.  Ride’s prospectus is dated May 6, 1994 and those of you who bought their stock at the time of the offering are patting yourselves on the back. Those of you who didn’t, aren’t.

Ride’s prospectus estimates expenses of the offering at $361,500. Morrow’s estimate is $900,000. They pay these expenses for the privilege of filing quarterly and annual statements with the Security and Exchange Commission (SEC), dealing with shareholders, revealing information they’d rather keep confidential, paying for audited financial statements and legal fees and holding annual meetings.
I can tell you from experience that to prepare their company to do all this, they went through a process which, besides being expensive, distracted senior management from running the business, was stressful and involved a high level of uncertainty. Why would they do it?
For the money, dude. But it’s not quite that simple. Basically, there are five financial benefits to going public.
First, the company receives cash from the sale of shares. In the case of Ride, the net proceeds were $4,138,500. Morrow hopes to raise something like $19,000,000. The company has great flexibility in how it uses the money. The Use of Proceeds section of the Ride prospectus says they expect to use $175,000 for office and warehouse equipment and the remainder for “working capital and general corporate purposes.” As non specific as that is, they then go on to reserve the right to use it differently “…if market conditions or unexpected changes in operating conditions or results occur.”
Basically, they can use it for any reasonable business purpose.
Second, it’s typical that the value of a public company is higher than a private company. As recently as April of 1995, Morrow sold convertible debentures with a conversion price of $3.67 per share. Remember they are hoping to go public at “between $11.00 and $13.00 per share.” If the offering price was $12.00, the company’s apparent valuation would have increased over 225% since April. Going public creates wealth.
Third, the company gains liquidity, and this in part explains the higher valuation. Shares in the company can now be bought or sold easily and efficiently.  The price is determined daily by the actions of (hopefully) objective third parties.
Fourth, the owners reduce their risk and can diversify their portfolios. Also, they make a lot of money. Morrow expects to sell 1,600,000 shares to the public but current shareholders will sell an additional 530,000 shares personally. The net proceeds from sale of those shares (around $6 million) will go directly to those individuals.
Finally, the company creates an asset that doesn’t show up on its balance sheet; the ability to sell stock. There are restrictions to how much you can sell, when, and at what price.  Some restrictions are legal one, and some the result of how the financial markets view the sale of new shares. But in general the public company has easier access to capital.
In August of this year, Ride did a secondary stock offering. The company sold an additional 1,165,400 shares and existing shareholders (directors and officers of the company) sold 834,600 shares they held at a price of $17.00 a share, succinctly demonstrating the value to the owners of a public offering and a successful company’s ability to raise cash after it is public.
The process of doing a public offering starts when a company goes into registration, submitting a registration statement and a draft of the prospectus (known as a “red herring”) to the SEC. Depending on how recently the company has done an offering, and how well known the company may be, the SEC may decide to have no review, limited review, or full review. A review will typically take about a month. It results in the company receiving comments from the SEC that require changes and/or additions to the registration statement and prospectus.
If there is no review, or when it is complete, the road show can begin. The road show is a series of meetings and presentations with interested investors and institutions in different cities. These meetings allow the company and its investment bankers to create interest in the offering and to evaluate how it should be priced.
Following the road show, the stock is priced in one or more meetings between the company and its investment bankers. The price depends on a variety of factors including market conditions and the reception during the road show. Once the deal is priced, the prospectus can be printed with complete information and become effective. The prospectus and stock are distributed to interested institutions for sale to investors and the stock begins to trade.
The draft I have of Morrow’s prospectus runs to 66 pages. Ride’s was 48. Both have sections entitled “Additional Information” which makes the reader aware that the prospectus does not contain all the information in the Registration Statement filed with the SEC. It notes that “Statements contained in this Prospectus as to the contents of any contract or other document are not necessarily complete…” and informs the reader that they can get copies of these documents (which, including exhibits, can run to hundreds of additional pages) from the SEC.
The form and content of a prospectus is clearly defined by the SEC. It is a carefully choreographed document that results from a certain level of creative tension between the company executives, the lawyers and the investment bankers. They all share the goal of getting the company public. The executives and investment bankers want the prospectus to be as positive a document as possible to improve the prospects of selling the shares at the best price. The lawyers are more cautious. Their job is to make sure that all the relevant information is disclosed completely and accurately, whether it is negative or positive. Lawsuits by investors claiming inadequate or inaccurate disclosure in the prospectus are not unusual.
My favorite example of how language gets crafted is in the Morrow prospectus when they talk about manufacturing risks. When discussing the company’s ability to get the materials it requires for manufacturing, they say “In addition, the Company has experienced limited delays in the delivery of certain raw materials due to delay in payment for such materials.” Those of us who are less eloquent than attorneys might have said “Their suppliers wouldn’t ship any more until they paid for what they’d already received.”
Obviously Morrow is far from the only snowboard company to have a tight cash flow, and one purpose of the offering is to prevent that from happening again, but you can see how it can pay to read some of the fine print carefully.
The Table of Contents to Ride’s prospectus dated May 6, 1994 is reproduced in the box below. Morrow’s is the same except for a few words and the order of presentation. We’ll talk briefly about some of the sections.
Table of Contents                                  Page
Prospectus Summary                            3
Risk Factors                                         6
Use of Proceeds                                   12
Dividend Policy                                     12
Dilution                                                 13
Capitalization                                        14
Selected Financial Data                         15
Management’s Discussion and Analysis
  of Financial Condition and Results of
  Operations                                          16
Business                                               18
Management                                         22
Executive Compensation                       24
Principal Shareholders                           27
Certain Transactions                              28
Description of Securities                       31
Underwriting                                          33
Shares Eligible for Future Sale               36
Legal Matters                                        36
Experts                                                 36
Additional Information                           37
Index to Financial Statements                F-1
The prospectus begin with a summary and moves on to “Risk Factors.” Morrow and Ride take six pages to talk about what could go wrong; foreign exchange, seasonality, ability to sustain growth, weather, dependence on key individuals, product liability. The list goes on. It gives the potential investor insight into the business risks, but is also important in protecting the company from lawsuits for inadequate disclosure.
“Selected Financial Data” is summarized historical income statement and balance sheet data. I always ignore this and proceed directly to the detailed, audited financial statements. The “Management Discussion” puts into words the financial relationships you’ll note yourself in reviewing the financial statements and explains the conditions that led to those results. The “Business” section talks about the industry, the company’s strategy, and its basis for competing.
Now it starts to get really interesting. “Management” describes the age, position and background of the company’s executives and directors. “Executive Compensation” tells you who is paid how much in salary, bonus and “other.” “Principal Shareholders” lets you know who owns how many shares, and what percent they own before and after the offering.
Now comes my favorite section: “Certain Transactions.”   This is where you can hope to  learn how the company really got financed before its public offering. You learn about stock issued for services, loans from family members of officers, private placements to officers and directors and their families and other interesting transactions. I always smile when I read about them, but it’s partly in admiration for people who figured out how to get the job done.
“Shares Eligible For Future Sale” gives you some idea what the “float” (number of shares actively available to trade) will be. Morrow’s prospectus indicates that after completion of the offering, but assuming no exercise of outstanding options or warrants, there will be 5,061,045 shares of common stock outstanding, but that only 2,130,000 will be eligible for sale to the public without restriction. The others are restricted either for legal reasons or be agreement with the investment bankers doing the public offering. They will become eligible to be sold as described in this section of the prospectus. As and if they appear on the market, the supply of Morrow common stock will increase. All other things being equal, increased supply reduces demand and, therefore, price.
Now you know a little about what it means to go public in the US and what’s to be found in a prospectus. Only the substantial financial rewards to the company and the shareholders can justify the expenses, distractions and continuing obligations the process inflicts.

 

 

SIA Member Services; Run Your Business Better: No Charge

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I think the first time I heard about SIA it was when somebody asked me to write a check for membership. “What are we going to get out of this membership?” I asked. “We have to be a member to go to the show,” was the less than enthusiastic endorsement. So I signed the check.

Turns out there’s more to it than that. SIA offers its members no charge services that, if utilized correctly, will add to your bottom line. The mystery is why so few members utilize them. Maybe a little publicity will help.
 
The Credit Services Program gives companies a picture of the payment status and credit quality of retailers they are doing business with. Produced seven times a year (January through May, August and October), this report shows the amount and status of all reported debt more than 60 days past due. It includes not only information supplied by SIA members, but by the credit associations of other action sports trade groups.
 
The report I received in August was about an inch and half thick. The only cost to participate is the time it takes to complete a form which shows the name and address of the account and the amount 60 days or more past due. There’s room for a short comment on the account status.
 
The information is reported by a member number. The name of the reporting company is not disclosed except to Riemer Reporting Service, which assembles the data.
 
Let’s say you’re doing about $2,000,000 in business annually (an estimate of the mean revenue of SIA members). Your business continues to be highly seasonal, and your customers are demanding better payment terms. SIA reports that overdue accounts represented 4.8% of sales at wholesale, or $96,000 for your typical SIA member.
 
Not all of that will ultimately be uncollectable. But after taxes, a lot of businesses are lucky to drop 4.8% to the bottom line. Better management of your bad debt expense can easily be the difference between a profit and a loss.
 
The in season cash flow affects are harder to illustrate, but may be more important. As I’ve said in this space before, companies pay their bills with cash, not with profit. A lot of snowboard industry companies live hand to mouth during the period between the arrival of product and collection of receivables.
 
What happens if, on average, your collection period goes from 60 to 90 days? How much more money will you have to invest in the business? Where will you get it? What will it cost?
 
Just for fun, let’s say you can borrow money at 10% annually.  To carry $2,000,000 in receivables an extra 30 days costs you about $16,700. The calculation is oversimplified, but you get the picture.
 
SIA’s Credit Services Program is part of an effective program to reduce your bad debt exposure. Checking credit references is important, as is your history with the account. But nobody ever handed out bad credit references, and conditions change from year to year. If by participating you can sell more product to accounts that pay, and pay on time, isn’t it worth the few minutes it takes to fill out and send in the form? You bet.
 
Often, public relations doesn’t make it on our radar screens, though when somebody says “advertising and promotion” we perk up and get out our check books. To paraphrase Clauswitz, public relations is advertising and promotion carried on by other means. Working with SIA, you can do some good public relations work that’s inexpensive to free.
 
Sort of my accident I got my hands on SIA’s New Products, Best Values publication. This annual publication, distributed to hundreds of media people and anybody else who wants it, gives each company a chance to briefly describe its latest products. Having a listing is free, but only 30 board companies participated this year. Since the show, SIA has distributed about 1,200 hundred copies.
 
We spend six or seven thousand dollars on a Transworld ad that we wonder if anybody is going to notice, but we won’t take the time to get some information in the hands of people who are specifically requesting it.
 
Call SIA and get their free booklet on press relations. Tell them you want to participate in New Products, Best Values. Then call them again and ask what you should be doing about public relations and how you can do it. The information and advice you can get for free would cost you thousands of bucks from a public relations firm.
 
Finally, there’s the Cost of Doing Business and Compensation and Benefits Survey. It’s just as expensive as all these other SIA services; you got to participate.
 
Inaugurated only in 1994, this survey is focused on developing accurate financial information on the snow sports industry. Only participants receive the report. The submitting company is known only to an outside accounting firm that receives the information. The tabulated data is released only in composite form. It shows expenses as a percentage of sales, not in hard dollar terms. In other words, participants are well protected from disclosure of proprietary information.
 
The data is broken down by small and large companies (with $5 million being the cut off) and by hard and soft goods. Right now, limited participation is making the information less valuable than it will ultimately be. Only 82 companies (out of an SIA membership of 850) are participating, but less than 20 are snowboard or snowboard related. SIA is prepared to run the data for snowboard companies separately as soon as there’s enough participation to make the numbers meaningful. 
 
There are two basic reasons to participate. First, it will let you know how you’re doing compared to other companies, highlighting what you’re doing right and where you can look to improve. Second, it can be very valuable in dealing with your bank or other financing sources.
 
For most industries, banks have “common sized” financial data that allows them to compare your company to others in its industry. Not so with snowboarding; until now. This kind of data is something of a security blanket for bankers unfamiliar with an industry. It will allow you to explain how your company is doing compared to similar businesses. The fact that you even have this data and have considered its implications will improve your credibility, giving you and your banker a common point of reference.
 
Using SIA’s services and information correctly will improve the way you manage and finance your business. Do yourself and the industry a favor; participate. Fill out the forms and send them back.

 

 

Where Have All the Snowboards Gone? The Apparent Imbalance Between Production and Sales

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I seem to remember from my first economics class that if supply goes way up and demand doesn’t keep pace, prices can be, well, negatively impacted. When I look back at the 1994-95 season, I am disturbed because it appears that there were more boards produced than were sold to retailers; maybe a lot more.

Below, I try and estimate just how many more. With so little hard information out there, that’s a tough thing to do with any confidence. But because the answers will affect how we run our businesses and how successful we are, it’s worth the effort.
 
My information is based on what I’ve read, some third hand conversations, rumors, insights gained working with snowboard companies, and some educated guessing. My numbers are not precise, and I’d like nothing better than for somebody to prove me wrong. 
 
If I were to guess how many boards were sold to retailers during the 1994-1995 season in the United States, I might estimate 225,000. Conventional wisdom says that the U.S. is one third of the total market. If that’s accurate, there were approximately 675,000 boards sold to retailers world wide.
 
My instinct is that the number is over 800,000. Using that number for discussion purposes, let’s talk about how many boards were produced.
 
I’m pretty confident that Pale and Elan together produced over 400,000 boards. Let’s say that Burton, Morrow, K2, Lamar, Gnu/Libtech and Rossignol together made 450,000 in factories they own or control for their own brands or others.
 
That’s a total of 850,000, which would be consistent with my estimated sales number if I wasn’t ignoring Atomic, Spaulding, Blizzard, Carnival, Thermal, Surf Politix, ASM, Niedecker, Volkl, Dynastar and a host of others that make their own and/or other brands.
 
At a minimum, I think production for the 1994-95 season was 1,100,000 snowboards. One knowledgeable source said the number was closer to 1,500,000. That means there would be between 300,000 and 700,000 unsold boards out there, not counting what retailers still have.
 
That raises some interesting questions. Like, for example, where are all these boards?
 
Maybe a distributor has them all in a warehouse somewhere, waiting for a good time to unload them.
 
Japan. They got to be in Japan. That’s actually the opinion of some people, and if you accept the conventional wisdom that there’s enough pairs of skis in Japanese warehouses to satisfy the market in 1995-96 if not a single additional pair was imported, it at least seems plausible. Certainly the Japanese have the balance sheets to support holding that much inventory.
 
Maybe it doesn’t matter where they are if they exist. At some point in time, they will appear on the market. Are your brands so well positioned that customers will still pay full price rather than buy a new, one year old board with essentially the same construction for a huge discount?
 
Think on it. What do you need to do differently as the market changes?

 

 

Foreign Exchange Management; What’s All This Brouhaha?

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Actually, there’s nothing to it. The differential in rates of inflation between the economies of two countries equals the percentage change in the exchange rate over the same period. This is known as the Purchasing Power Parity theorem.

There. That should be clear. Of course, government intervention in the markets can also affect exchange rates and everybody knows that in the short term currencies with higher interest rates tend to be stronger, but of course the dollar has plummeted recently following a series of short term interest rate increases by the Federal Reserve, and various tariffs and trade barriers affect rates, so I guess that’s not always right.
 
What we really ought to do is read the 78 pages of fine type in Financial Accounting Standards Board pronouncement 52 that deals with accounting for foreign exchange transactions. Then this wouldn’t be so confusing.
 
On the other hand, we could say screw it. Unless we’re buying or selling in a foreign currency or, as a retailer, have a lot of time, effort and money invested in establishing and promoting a brand you’d like to see survive and offer better prices. Or unless you’re making boards (or other products) in the U.S. and exchange rates affect how your competitors price their products. Or unless you’re exporting boards and getting paid in a currency besides dollars.
 
The hypothetical U.S. based company BFD Snowboards is buying boards from that European snowboard manufacturing behemoth EPS. BFD is only buying 5,000 boards and EPS’s capacity is sold out, so they can insist that BFD pay for the boards in their currency. Let’s let our imaginations run wild and assume it’s the German Mark.
 
In spring, BFD opens a letter of credit (LC) through their bank in favor of EPS. Let’s say all 5,000 boards are the same and each costs 200 Deutsche Marks (DM 200). This board is hot. All 5,000 are committed to dealers (must be a signature board). BFD’s letter of credit is for DM 1,000,000 (5,000 times 200).
 
That’s as complicated as we’ll let this example get. In practice, partial shipments up to the total of the LC may be permitted, EPS may be allowed be over or under the DM 1,000,000 by maybe 10%, and some of the boards shipped may be second quality boards that carry a lower price. In addition, assuming BFD is buying ex factory (that is, they are responsible for all the costs after the boards leave the factory door) they will spend six to seven percent of the purchase price in freight (more if it’s air freight) and customs duty to get the boards to the U.S.
 
What these variables mean is that the actual DM amount you have to pay may be higher or lower than 1,100,000 and there may be more than one payment date.
 
The LC is opened in April. An LC, for those of you who have had the good fortune not to have to deal with them, is a promise made by a bank to pay a certain amount of money upon receipt of specific documents indicating shipment of the correct merchandise the right way, by the time required. Note that the bank pays based on the documents. There’s no protection against fraud. If the boxes get to BFD and are full of P-tex scraps, the bank has no liability if the documents they paid against were as required.
 
In April, then, BFD has a potential liability for DM 1,000,000. It doesn’t become an actual liability until EPS ships the product. If the exchange rate at the shipment date is, say, 1.60 DM to the Dollar, BFD will have to come up with $625,000 (DM 1,000,000 divided by 1.60) to pay for the merchandise. That payment date depends on the terms of their agreement with EPS.
 
Assuming it costs them about DM 12 for freight and duty, BFD’s landed cost for each snowboard is DM 212, or $132.50 at the exchange rate in effect when the LC was opened. Now BFD wants to earn a little money itself to pay for lift tickets, so it marks the product up and sell it to retailers for $172.25, giving BFD a gross profit of $39.75, or 30 percent.
 
Ah, but we forgot about that moving exchange rate. BFD had to price their boards before the letter of credit was ever opened so retailers could show up at the shows and know what they were going to pay for it. If, at the time BFD set their prices, the exchange rate was 1.70 DM to the Dollar, BFD is bummed. As the Mark has strengthened from 1.70 to 1.60 (strengthened because you get fewer Marks for each Dollar) BFD’s dollar cost per board has risen from $124.71 (DM 212 divided by 1.70) to $132.50 (DM 212 divided by 1.60). If, on the other and, the Mark was at 1.50 when BFD set its prices, it is mighty happy, because its dollar price per board has declined from $141.33 (DM 212 divided by 1.50) to $132.50 (DM 212 divided by 1.60).
 
The difference between a cost of $141.33 and $132.50 is 6.25%. To put that in perspective, it’s enough to be the difference between a profit and a loss for the year. For BFD, it’s a swing in gross profit of $44,150 on the sale of the 5,000 boards.
 
Exchange rates move every day. A lot, a little, up, down; there’s no way to tell. If BFD just waits until they have to pay EPS marks, it will have to pay whatever number of dollars the market dictates at that moment. That’s one possible strategy. There a couple of others.
 
At any time you can buy the marks you need and put them in a bank account in Germany earning interest. The marks will be available to pay EPS as required, and you will know your exchange rate and, therefore, your cost.
 
Choice two is to buy a forward contract. A forward contract is an agreement entered into with a third party, usually using a financial institution as an intermediary, to buy or sell a given amount of foreign currency at an agreed upon exchange rate on a specified date. Forward markets for major currencies are broad and deep. You can generally buy or sell whatever amount you need for delivery at the date required. The forward rate (that is, the exchange rate at which you buy or sell a currency for future delivery) is determined by market expectations.
 
BFD is buying DM 1,000,000 of boards from EPS. Let’s say EPS ships the boards May 15. The documents from the shipment go to EPS’s bank and then to BFD’s bank to be “negotiated.” The letter of credit calls for terms of “sight 60.” That is, BFD’s bank, and therefore BFD is required to pay DM 1,000,000 60 days after documents receipt. If the documents are received May 23, payment date would be July 23rd.
 
BFD decides the dollar is as strong as it’s going to get before payment is due and that, in any event, it doesn’t like it’s profitability to depend on the whims of an unpredictable market. It instructs its bank to purchase forward DM 1,000,000 for delivery on July 23rd. The bank enters into the contract and BFD now knows exactly what those boards will cost it. It no longer cares how the Mark moves against the Dollar between now and July 23rd. It’s cost in dollars will be the same.
 
On July 23rd, BFD receives the marks, paying dollars for them at the contracted exchange rate, and orders its bank to transfer the marks to EPS’s bank account to satisfy its liability to EPS. Depending on how the dollar and mark have moved against each other in the period between the date the forward contract was purchased and the date it matured, BFD’s financial manager may feel like a hero or an idiot. But a major source of financial risk will have been removed.
 
The third option involves what’s called asset liability management. Let’s assume BFD doesn’t really know anything about the U.S. market, but has convinced some Japanese distributor that it is a cool brand and that Japan really needs another snowboard (obviously, this is a hypothetical situation.). The Japanese distributor agrees to buy 4,000 of the boards, to pay for them in German Marks at a price of DM 250 per board, and that payment is due July 23, the same date BFD must pay EPS.
 
Suddenly, BFD has a perfect balance sheet hedge. They have an asset of DM 1,000,000 they will receive from the Japanese distributor and a liability, due the same day, to EPS. They no longer care how the dollar moves against the mark because they will not have to convert one currency into the other.
 
If you’re exporting and getting paid in a foreign currency, the problem is the mirror image of paying for imports in foreign currency. Most companies I know of solve this problem by insisting on payment in dollars.
 
Now you know a little about how foreign exchange risk arises and how it can be managed. You may also have realized that even if you don’t deal in foreign currencies, your suppliers and/or competitors probably are. That affects the prices you pay and the profit you can make and is worth a few minutes of thought.